Great, so we'll jump right into the session here. First, I'd like to say thank you, François Morin-
Thanks.
CFO of Arch Capital Group, for joining us. Very much appreciate you being here.
Thanks for having me.
So I've been starting these conversations off with a more broad strategy question, and I'll do the same here. So first, I just wanted to get your updates on, you know, what you're most focused on in the business, key strategic objectives, particularly as we think through, you know, the next year.
Yeah. Thanks again. Good morning, everyone. I'd say, you know, we are at a quite an interesting time in the market, right? We see a lot of good opportunities in all three segments in which we operate in. So the focus for us for 2024 is all about capital allocation, right? And that's something that we've, I think, have been very focused on for forever. And kind of keeping that focus on, you know, deploying the capital in the best opportunities that give us the better returns, I think is really how we think we'll win the game, right? So I'd say that's absolutely top of mind. And part two is market discipline.
You know, we've enjoyed very good conditions for you know a few years now, and those have gotten better, certainly in the reinsurance front for us in the last year. Plus, we expect those to remain very strong in 2024. So kind of, again, in the theme of capital allocation, but also kind of, you know, where do we push the hardest? I think that's going to be very important to us in 2024.
So I want to focus in on that specifically, in the reinsurance. Could you maybe first help us think through, you know, what's happened over the last year? And certainly, we all see the rate numbers, but maybe also just terms and conditions and the way your book has shifted, and why all of that is such an opportunity for Arch.
Yeah, I'd say, and broadly speaking, you know, I called it 2023, the year of property, right? I'd say, we had grown, you know, and if I go back five years ago, we were a fraction of the size that we are today on the reinsurance front. Footprint was, but the footprint was kind of the same, right? The infrastructure, the platform we had, you know, U.S., Bermuda, Europe, I think was very much the same, but the market just wasn't nearly as good. The market got a bit better, certainly starting in 2019, 2020, you know, the last few years. And you saw us write more property even in 2022.
But 2023, right, I think certainly property cat became a big theme and something that we were able to execute on, and that was, I'd say, you know, quite a game changer. So as we think about, you know, property in general, both cat and non-cat, 2023 was certainly a year where we did a lot more. But, you know, I'd say the market was there for us. I mean, I think of, you know, property fac, for example, for us, which is, you know, has become quite a sizable part of our property non-cat business. The market has just really exploded, so it's been really good on that front.
And then I bring in kind of the other lines of business, where now we're, you know, we're expecting property to remain very strong, but, you know, there's you know, we do a lot more than just property. So casualty is an area both, call it, you know, professional lines, you know, the D&O angle, which, you know, is maybe not has maybe peaked, I'd say, maybe coming down a little. But there's a lot more to casualty that we do that, you know, we think has opportunities for us as we look into 2024. So I think we're, you know, we're very positive about the broad kind of sector in reinsurance in general, and then within that, there's always some pockets.
So I definitely want to come back to the points you're making on casualty.
Yeah.
Before I leave property, I was interested if you could talk a bit about the supply and demand dynamic in particular.
Yeah.
I know, you know, as people are watching interest rates drift down a little bit, they're thinking through, "Well, what's the sensitivity to all of this, the interest rates?" Is it more than that? What are the structural things that are impacting it?
Yeah, I'd say capacity in general is, is pretty stable. I think, there's been some pain in the last few years around... You know, certainly, cats have been sizable, and, there's been, you know, the, the, the, the interest rates moving up has created some pressure on the mark to market for, for some companies. So I, I think, there, there's been, 2023, you know, knock on wood, will end up being a, a very solid year for, for the whole industry or for the whole sector, and that has certainly helped, incumbents and existing players kind of bulk up or, or, or, kind of, I'd say, fix some issues with their balance sheets.
You know, there was a little bit of a pullback on the third-party capital that took place, you know, in 2022 and along, you know, for the last few years. Is some of that coming back in? We think so, not, not in a systematic or major way, but we think there's a little bit more supply coming through, from third-party capital. Does that impact the discipline? Does that impact kind of how the, the market behaves? We don't think so at this point. I think there's still very, very, you know, telling signs that, that the, the discipline is there. People are, are not kind of chasing the business, so I think it's, it, you know, those, you know, it, it, you know, makes for a healthy market.
Yeah.
And back to your question, I'll just quickly, I just wanted to touch on terms and conditions, which-
Yeah.
... you know, are part of the story. I'd say it's not, you know, when the market corrects in a major way like it did on the property side, you know, a year ago, I think it's just human nature that the terms and conditions end up being quite strict. I mean, quite extensive. I mean, the changes, it's a massive step up in terms of conditions. You look at it back a year later, sometimes some of the terms and conditions that were put in place are actually didn't really apply, but people just it's the kind of throw everything at it, and it sticks, and you just have it.
There may be a little bit of a pullback in 2024 as people are a bit more realistic about, well, what are we actually gonna what's the understanding here of the transaction? What are we what do I need in terms of protection? And what's, you know, what are the reinsurers kind of willing to give in on?
Got it.
So there could be a little pullback, but we don't think it's... You know, our view is that it's gone very, very hard, so even if we give back a little, it's not gonna be a game changer.
Understood. And, you know, I think a big part of the conversation, too, has been around the demand for reinsurance. And certainly, you know, higher retentions and so forth were taken this year, and it was a particularly tough year for certain types of smaller catastrophes.
Yep.
How are you seeing all that manifest itself in the opportunity around your end this year?
Yeah, I think there's... We paid the price, and others did it as well. I'd say going back a few years where the aggregate covers that were kind of intended to cover frequency of events were very you know very much a part of the market, and we would argue, I think probably underpriced. So to... You know, and the experience shows it. So the market in general, I think, has you know the reinsurance community has pulled back from that type of product.
You know, the right word, it's in a little bit of a transition where people are, you know, trying to factor in all the, you know, climate change and everything that goes with, you know, how do you think about the risk that you're assuming from the property side? So that, kind of that product, for the time being, I'd say, is probably not really available. You're right, you know, with the market, the reset retentions went up.
What we see happening, though, and that was always part of our thinking, was, you know, primary companies have gone through, both on the personal and on the commercial line side, have gone through a pretty extensive revaluation process to come up with the right values on the insured, you know, the right insured values.
Right.
And it's, you know, homeowners, I mean, I'm sure most people here, you know, will notice that when their renewal comes up for their homeowners policy, the home price, the value they put on the house has gone up quite substantially in the last year. And commercial is always a more complicated kind of exercise. Certainly, when you have multiple locations, you got to think through of all the interdependencies. You have BI, you have tons of other coverages that impact the insured values. But that whole process of revaluation has gone through. Is it done? We don't think so, but there's a lot of it that's actually now starting to flow through the numbers.
So when you get back to a property cat program, the carriers are realizing that, hey, now I, you know, my TIV has gone up from, you know, you know, by a quite healthy percentage in the last year, which means I need to buy more coverage. We think that additional demand will effectively kind of mean more limits being purchased at the top end of the programs. Some carriers may try to bring down their retentions. You know, we'll see how that plays out, but we do expect a bit more demand for the product just based on, again, the fundamental, just revaluation process that's going on.
Yep. So I want to come back. Before we leave reinsurance, just come back to the casualty.
Yep.
You know, I think you all have been sort of maybe recognizing some of the things that were problematic around casualty over the last several years, and you've also more recently maybe been the first to say that you're seeing some progress and potential momentum behind price in that market. So would love to hear you unpack that a little bit. And, you know, is that something that is actually going to happen in 2024, or are we over optimistic about it?
I mean, I don't have the crystal ball, but we're you know, that's certainly our view is that casualty has gone. There's more pain to be recognized on the casualty side. We think you know, the extent to which the soft market years have been the ultimate kind of loss picks have been recognized on those years is we think there's more to come. And ultimately, when that is done, that is effectively reflected in you know, in the financials, I think companies will recognize that there needs to be just a different reset, a different starting point of what the exposure is.
So it always starts, you know, always, but I mean, in this case, we think the primary companies are the ones that truly are leading the charge, right? Recognizing that you know, when I write a policy that has, you know, it's and it could be any subsector of the casualty market, understanding the exposure, and then we get into, you know, what impacts the ultimate performance. Again, it's inflation concerns, it's courts reopening after COVID. There's you know, as we know, there's a lot of factors that impact the performance of that, the you know, that line of business in general. I think, you know, now we're seeing more data coming through. We see it both on our primary operations, we see it through our reinsurance operations as well.
So we're positive that, you know, this data that's coming through will impact how people perceive the risk that, you know, they're assuming. They'll have to charge for it, obviously. And, you know, and you're seeing it already come through in kind of the rate changes that are being published by, you know, some, you know, the surveys in the industry, where we're seeing a reacceleration of casualty rate effective rate changes in the second half of the year. So I think there's more to come. We don't expect it to be a stairstep like property was, you know, at 1/1, but we think there's a good rationale to get us to where we think it may end up in it over the next, call it, couple of years.
Now, how would you describe, like... the return profile of that opportunity versus cat is pretty different in terms of the volatility, so not-
Right.
... directly comparable. But, I mean, how do you think through the opportunity there versus what you've got in property cat?
I mean, it's, I mean, we'd like to play in both. Obviously, we were, you know, we, we're, we're not really at this point from the Arch side. You know, we've got capital to work with. I think we, we've been able to generate, internal, you know, internally, kind of, capital base has grown. So I think that gives us the ability to, to really be able to play in a meaningful way in both, both, both sectors. You know, our property guys will, will keep writing the property as long as they feel like they're getting the rate that they think is, is necessary, given the exposure we're writing, and same thing on the casualty. So no question that on a, you know, on a, on a peak zone, kind of, very specific, property deal, you might get better expected returns.
But we also recognize that, to your point, that it's more volatile. So we think we deserve that. We try to get that. On the casualty side, you know, certainly, we factor in a bit more investment income, and with the rates going up, I think that's a positive. So when we look at the whole thing, you know, they're closer than you think in terms of absolute returns, given, you know, the investment income angle on the casualty side, which is meaningful.
Interesting. Okay, so let's move over to the primary business. Maybe just broad question for starters there. You know, what are you most focused on when you think about that business and the opportunities? Go ahead?
Yeah, I think our insurance practice or insurance segment has really transformed itself from five years ago, where we were, you know, we certainly were not satisfied with the performance that we were getting out of that market or that segment. But by the same token, you know, if we're being totally, you know, transparent here, I mean, we all know that it wasn't a really good market either. So at some point, you know, there's only so much you can do given the market that's in front of us, and we play a lot of defense, and we also feel like we were more realistic or very realistic about kind of the, you know, expectations around combined ratios or initial loss picks.
So I think, you know, that was the reality back then, that the whole market, and you've seen it through, you know, the rate changes, rate increases in most lines of business and on the primary side, come through in the last three to four years. Those, in some lines, have tempered, and yes, we've all heard about D&O and cyber in some places where rates are maybe coming down a little. But we are, you know, we're still very much active in those lines. We think the relative measurement is important, but the absolute measurement is maybe more important, right? So ultimately, are we hitting our targets? Are we hitting the returns that we think are required for this line of business?
And for the most part, we are still very much active in those lines of business. So that's kind of what we're focused on, really, is understanding. I mean, I don't want to say it's easy, but it's easier for sure, when you know, you price a risk and you know, you're at the renewal and you show up and the next year, like, the market is trending in the direction that we're going to get 20% more rate on the same exposure. It's easier for the underwriter to make the call and say: Yes, I want it again, and I want more of it. When rates start going the other way, I mean, there you have to have a bit more discipline around, you know, when do we say no?
When do we kind of pull back? And that's, you know, what we've, I think, hopefully been... You know, I think we've been able to, to do a lot of that over the years. We're, we're not in that, you know, this is not the time for that yet. I'd, I'd say maybe in some subsegments where there's, there's a bit of pressure, but for the most part, we still see 2024 being very positive on the rate side for the insurance group. And then it's a matter of kind of, again, capturing the better accounts, being selective, and, and kind of putting the capital to work.
Got it. So you touched on it some there already, but, you know, with the net investment income picking up, certainly, you know, commercial insurance ROEs for the, for the industry broadly, have gotten to a pretty strong place.
Yep.
You know, why isn't that translating into the kind of competitive pressure you might expect? And, you know, is it in certain pockets? How do you avoid that?
Well, we certainly don't tell, or, you know, our underwriters are focused on combined ratios. We can, at the group or at senior levels, do look at returns, which obviously impact how much capital we think we want to deploy in a certain segment. The flip response to your question, I mean, I usually like to flip it on its head and say, "Well, how come rates were so bad in 2015-2019 when interest rates were at kind of all-time lows or very low?" So that whole kind of, you know, the view that, you know, interest rates should have a meaningful impact on the rates we charge makes a ton of sense, but in reality, doesn't really seem to follow.
My view is that it's more around just how much capital is in the space, and whether people perceive that it's going to be attractive and whether how competitive they want to be. So at this point, there is not, you know, an oversupply of capital in the industry. We, you know, on the insurance side, for sure, and broadly speaking. And we feel that, you know, what we're seeing is competitors being very, again, very disciplined in how much capital they're willing to deploy, given the uncertainties around the lines of business. And for those reasons, like, you know, investment income is a nice add-on, but doesn't really factor in at this point into the pricing levels quite yet.
Got it. So I wanted to circle back on, you know, the financial lines, particularly D&O, you mentioned-
Yeah.
... the pricing pressure that's there. Could you help us think through that? I mean, I hear you absolutely, as long as it's still in a good place, is great. You know, I think we've seen some of the securities class action lawsuits tick up, and some of the loss trend things are sort of maybe getting a little worse just as pricing is coming down. How do you navigate that? You know, why are you comfortable still sort of playing where you do?
Yeah, I'd say. I mean, my view, our view is that, you know, certainly a lot of the additional—I mean, the markets that we had new entrants, a little bit on the heels of what people perceive to be very good, well-priced years on the D&O front.
Right.
And, a lot of that, you know, demand for the product was driven by IPO activity and SPAC and de-SPAC activity, which pretty much dried out in the last year plus, right? May pick back up in 2024, but, you know, the last year and a half or so have been relatively quiet on the, you know, IPO transactional liability front. And those new entrants that had been established were, you know, looking for a way to, you know, get some premium, right? To justify their existence a little bit.
So that's where you saw the most pressure is certainly on the excess commercial large commercial D&O on excess layers, where, you know, it's relatively simple or not overly complicated to show some capacity and participate in those programs, which brought down the pricing. You know, and that's been really, I'd say, the main area where you see more pressure. I think a lot of the private D&O, you know, asset manager, there's other categories within the D&O space that didn't, you know, move nearly as much as a large commercial did. And, you know, there's still accounts that we like. I mean, to your question, you know, on like class actions and how do we think about that? We think that's, you know, certainly something we're watching.
It's never, you know, it's never a perfect science. I mean, sometimes there's a flurry of activity on that front, and some of them stick, some don't. So but we're certainly aware that it's something we need to... Well, we always have been tracking it, but it's-
Yeah.
... it's certainly gone up in the last, call it, six to nine months. And you know, being selective in how you deploy capacity limits, where you play in the towers, is, I think, a way that you can certainly minimize the downside and be kind of still generate good returns.
Got it. Let's shift gears over to mortgage insurance.
Yep.
Maybe first, I want to ask you about some of those transactions that you made an announcement on recently, but maybe first, just broad view on the state of that market, credit quality, and, you know, what you're seeing in some of the initiatives.
Yeah. I mean, we, it's been, it's been terrific for us. I think mortgage has done extremely well. What we see today is certainly a book of business, of in-force business that has performed extremely well. We think, based on, again, what we, you know, what we have in front of us, will perform extremely well. Home prices is to us, the... And, you know, obviously, it matters tremendously in the performance of that book.
Yeah.
Home prices had gone up, so the people building up equity in their houses is critical to the long-term profitability of that book.
Yeah.
So that was excellent. We had some concerns, some doubts earlier this year, the start of the year, when, you know, maybe the economic data was suggesting that, you know, there could be time for a pullback or a recession. Here we are, almost a year later, and, you know, things have not played out as we thought they could. So, that's certainly something that we are benefiting from. And with mortgage rates being at the level they are today, what we see is a book of in-force business that will stick with us for a long time. So, there's a lot of value that's embedded in that book of business, high credit quality.
Again, persistency is at an all-time high, and no kind of macro economic kind of signs that kind of have us, you know, really concerned about the performance of that book. The downside, obviously, as we say, well, what's good for the in-force book is not always good for the new originations, and we see that because, you know, originations are down. The market is what it is. There's not a whole lot of people buying new homes or refinancing. But even though those that are, we think are still doing extremely well. Good credit quality, I mean, a bit of pressure on, you know, some of the other metrics like loan-to-value, debt-to-income, those kinds of things. But all in all, we're very happy with the mortgage segment and the prospects of it.
And our view is that at some point, mortgage rates will come down, and then that will kind of, I mean, kind of open up the origination market a little bit and give us-
Yeah.
... a bit more of new business.
Makes sense. So recently, you terminated some of the, I think it was Bellemeade,
Yep.
... securitization-
Yep.
... transactions. So I just wanted to see if you could give a brief background on what was done there, and if there's any financial impacts we need to consider?
Yeah. I'd say this was very much in the reaction to the S&P capital model that has got finalized in mid-November. So, I mean, big picture, the capital model specifically for the mortgage business changed quite substantially. The old model was a bit more punitive, so capital requirements were definitely higher, more granular, so very much loan by loan, very, very, very detailed model. And as a result of that, there was... Given that the capital requirements were quite substantial in the old model, you know, the purchasing of Bellemeade Securities can, you know, effectively buying more reinsurance, which effectively this is excess of loss reinsurance was an attractive proposition for us, right?
So managing our capital requirements through the purchase of reinsurance protection was a benefit to us. With the new model, the game has changed quite substantially. The capital requirements, you know, the gross or the roundup capital requirements have gone down, and the protection, the value we get on the capital—on the S&P side, in terms of the credit we get on the capital from those protections, from those Bellemeade part transactions, effectively went away. So, you know, for us, we had an option to exit, that we had the ability to exercise. So we've, you know, made, you know, we announced our intention, at least at this point, to take all those transactions.
But it's really around, you know, the credit or the expected recovery we're getting from the S&P model. In terms of financial impact, it's somewhat de minimis. I mean, it's accretive, but it's over a number of years, and in the grand scheme of the Arch kind of family, it's not really going to move the needle enough to kind of disclose it or-
Okay.
... but it's positive, yeah.
Understood. One of the themes that I think investors have been particularly interested in is just, you've got this mortgage business, you've been releasing some of these COVID, you know, vintage, reserves that were put up, and it's providing you more capital to go after the reinsurance opportunity. And so the question for you is really, you know, where, where are we in sort of the life cycle of that theme? I mean, there's, there's already been a fair amount released. You certainly had fantastic, mortgage earnings this last quarter. Is, is there still a runway there, or do you sort of have this capital and now it's about going after the reinsurance?
Well, the mortgage side, I mean, we don't know. I mean, the one thing, I mean, we've said it publicly, is the reserve releases for the COVID cohort of loans or mortgages or delinquencies is pretty much done. So whatever we set up in terms of reserves, those delinquencies that were reported to us, you know, right after COVID, and I call it, you know, 2020, those have pretty much been all released as those loans have cured and gone out of forbearance programs. Since then, though, I mean, and you've seen that a little bit in our initial loss pick or the assumptions around claim rates, we've been a little bit more conservative than we had been historically. So we started the years...
So people ask us, "How, where are those releases coming from?" I mean, you know, when we reserve for new delinquencies in the quarter, you know, we have a view on kind of ultimate performance of those loans. And you know, there was some concern around, again, home prices coming down and maybe unemployment picking up. So there's a couple of things that we were looking at that had us a little bit worried, and that's why we booked some of those reserves at a higher level in the last, call it 12-18 months. Does that materialize? At this point, it looks like, you know, some of that is actually running off favorably, so there may be more favorable reserve development coming through.
We don't plan on it, it just happens based on kind of the experience. But, you know, if that generates into more earnings and more capital for us to deploy, either in the mortgage segment or in others, in either insurance or insurance, absolutely, I mean, we'll do that, obviously. And that's kind of, I think... I wouldn't call it a secret sauce, but that's, that's what you get with the Arch story, is, is being, you know, quite capable and across three segments, to, to move the capital in and out and, and deploy it in the right, in the, in the better opportunities. We think that's what makes us different and, and hopefully better.
So in the same vein, I wanted to ask you on capital management broadly, certainly you've got this reinsurance opportunity. We were all-
Yep.
... focused on that. What are some of the other ways that you'll look to deploy capital?
Well, that's the focus, right? Right now, it's we got a great market. We know it won't be here forever. We are working day and night to make sure we maximize the opportunity or maximize, you know, the returns from that opportunity. You know, we'll reassess and. Well, we'll reassess. It's something we do constantly, but we'll have another data point after the 1/1 renewals, right? That will tell. That'll be telling in how, where the market's heading. How do we think about the capital we have? Do we need more? Do we have enough? Do we have too much? What do we do with it? Right now, I think, you know, we recognize it's a market in transition, so we wanted to make sure that, you know, we don't wanna miss an opportunity.
So let's kind of hold on to the capital, let's put it to work, and, I mean, you know, a lot of green lights in all the metrics we look at. So there's really not a. As long as we like the returns on the pricing, our units are, you know, doing the best they can to write that business. You know, again, the mortgage story has been tremendous in helping us kind of not have to go out and find other sources of capital. I think we're very comfortable with our capital position, but, you know, we'll go through that next step and then reassess what it may mean for us.
Understood. I wanted to ask another question on net investment income. I mean, certainly there's a lot of maybe more sensitive and impactful things going on-
Sure.
... in the margins in your businesses. But, you know, could you update us on where the new money yields are relative to the portfolio yields? How are that dynamic's trending, and are there any opportunities in terms of allocation and thinking-
Yeah.
-about environment?
Sure. I mean, I you know, maybe a little pullback in the fourth quarter into where the rates are. But, you know, big picture, right, there's about 150 basis points difference between our book yield and the new money yield. So when we think about wherever that new money yield, you know, I mean, moves over time, we think there's still room for us to, you know, as new maturities come through and we roll the money over, I think we'll, we should be able to even, you know, we will have a better book yield or a higher book yield, and that's, I think that's certainly a positive.
The one thing, though, that we have been, you know, I think, investing time and energy in the last couple of years is being more proactive on the, call it, the private side of the investment kind of story. So, you know, alternatives, you know, private loans, kind of the, you know, where we think that there's better given our stature, and we can make better, you know, bigger commitments. We can get better terms, we can get more better expected returns that way than just strictly through the public markets, I think is a way that we're trying to optimize and kind of generate, you know, higher returns. So, you know, a little bit more risk maybe to some people.
I would say, well, it's risk that we should be taking on anyway, given our size. I think we can take on that risk, liquidity concerns or, you know, I don't think we'll, you know, unlikely that we'll, there'll be a run on the bank on Arch tomorrow, and we'd have to liquidate everything. So I think we're taking the right steps to, again, just kind of realizing that we are at a certain size, we have the ability to do it, and, you know, while still maintaining a discipline that we see ourselves as being an underwriting company first, right? We're not, we're not a, you know, give us the cash, so we can invest it.
Yes, we need to invest it, but we need to retain our principles around being, you know, superior underwriters and, you know, leverage the investment side as well as best we can.
Understood. Well, we are at time, so I'll stop it there, and thank you very much.
Thank you.